Detroit's Gambling Bet Leaves It in the Red

Detroit officials have been working to bring the city out of bankruptcy by September 2014, a date that becomes increasingly unrealistic as intricate, financially unstable plans to save the city crumble.

In the latest example of plans gone awry, a federal bankruptcy judge last week rejected Detroit's plan to pay UBS and Bank of America $165 million in order to extricate itself from an expensive interest-rate swap deal. According to Judge Steven W. Rhodes, the city plan to offer gambling revenue (gleaned from Detroit's three downtown casinos) as collateral to Barclay's — which had agreed to loan Detroit the money it would need to repay UBS and BoA, plus more — relied on funds already tied up as collateral in previous deals.

In other words, Detroit is gambling on casino revenue it doesn't have, in a tragically fitting example of how difficult it will be for the city to lift itself out of fiscal quicksand.

Reuters reports that Detroit opened up three casinos in 1996, and has been relying heavily on their revenue, roughly $180 million per year, until it promised away the revenue in a Rumpelstiltskin-like deal:

In an effort to reduce its unfunded pension liability, the city sold $1.45 billion of bonds in 2005 and 2006, then used derivatives known as swaps to cut risk. The derivatives deal backfired as interest rates dropped, when Detroit expected them to rise. When Detroit's credit rating was cut to junk in 2009, banks had the option to demand $400 million, and the city fended off immediate payment by pledging casino revenue as collateral. The deal's continued threat to Detroit's financial future was one of the key elements that pushed the city into the largest municipal bankruptcy in U.S. history in July.

In the latest deal, Detroit was hoping to use these same casino revenues to secure a $285 million loan from Barclays that would release the city from BoA and UBS's hold, and leave it $120 million to manage the city. Theoretically, the deal would free up gambling revenues — which UBS and BoA would lose their right to once they received the $165 million — for use as collateral for Barclays. But Judge Rhodes argues that Detroit can't rely on the Herculean financial manipulation to make the deal, because it harms other creditors and would grant the banks money it doesn't deserve. The New York Times explains:

The ruling [to block the deal] was seen as a vindication for Detroit’s residents and its other main creditors, which stood to take a back seat to the new Barclays loan. They were arguing that the swap contracts appeared to have been illegal to begin with and should be voided rather than paid by the bankrupt city. Some even called for Detroit to claw back the millions of dollars it has already paid the two banks on the swaps.

According to the Times, the judge thinks the plan is little more than a desperate attempt that will hurt the city overall:

Judge Steven W. Rhodes of United States Bankruptcy Court, in a decision many viewed as a big surprise, said that Detroit had hurt itself with hasty and imprudent decisions in the past, and that the practice “must stop.” He ruled that Detroit could not proceed with a plan to pay $165 million to two big banks to extricate itself from some long-term financial contracts that have been costing the bankrupt city tens of millions of dollars a year.

The ruling is a rightful reminder that predatory lending practices harm people but benefit "too big to fail" banks. The judge's decision left city managers scrambling, but creditors cheering, according to the Christian Science Monitor:

Jordan Marks, executive director of the National Public Pension Coalition in Washington, issued a statement Thursday calling the Rhodes ruling “a win for Detroit retirees, who are at risk of being thrown into poverty thanks to unscrupulous practices on Wall Street.” “At a time when retirees stand to lose 84 cents of every dollar they earned, a payout to Wall Street is unconscionable,” Mr. Marks said.

Ironically, gambling returns have been performing poorly in recent years, thanks to competition from new casinos in Ohio. Maybe the deal would have allowed a city to pull one over on Wall Street, for once.